What is liquidity?
Liquidity as a term is defined as the ability to buy or sell assets in the market without causing radical changes in the price of the assets.
Liquidity can refer to two different areas; liquid market and liquid assets.
A market is liquid if there are always investors ready to trade. An asset is liquid if it is easily converted into cash.
But what do we mean when we talk about cryptocurrencies?
As with any investment, you want to be able to buy and sell tokens quickly without having to wait too long for the price to drop or for the deal to be agreed upon. To make this possible, the market you are trading in needs to be liquid. In other words, there needs to be a lot of trading activity and the bid and ask prices should not be too far apart.
Let's look at an example from the seller's point of view;
Bob has 5 tokens of a certain cryptocurrency and the price of these tokens has increased in the last few days. Bob is happy about this and decides to quickly sell the tokens at the current market price.
If the market is liquid, meaning there are enough buyers willing to buy Bob's tokens at his price, then Bob has the ability to sell his assets quickly and at the price he wants. Bob's deal does not affect the token price because the market is liquid enough to accommodate Bob's deal.
At the same time, if Bob tries to sell 5 tokens at the current market price, and the market is illiquid or has low liquidity, meaning there are not enough buyers willing to pay the price Bob is asking, then he will be forced to lower the price or wait for higher liquidity to sell his tokens. If Bob decides to sell the tokens at a lower price, then his transaction will affect the current market price of the token.
How to determine if a market is liquid
When considering whether a market is liquid or not, it is advisable to look at three important metrics. The 24-hour trading volume, the order book volume, and the amount by which the bid price exceeds the ask price, also known as the bid/ask spread.
However, the order list may not always reflect the actual situation due to factors such as stop limit orders and iceberg orders, which are created using automated trading and as a result do not always appear in the order list until specific conditions of these orders are met.
Liquidity is extremely important when considering your trades. It is one of the main factors for entering or exiting the market easily.
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